Industrial Organization

Please see the attachment

Econ3319 (2013) Assn 2: Horizontal Product Variety Under
Competition & Measures of Market Concentration

Ruth Forsdyke, © 2013

Due: Wed. Nov. 6th in class.

Textbook sections:
Ch. 9 (pg. 154 – 155), Ch. 6 (Section 6.4.)

Please show your mathematical work using short sentences to guide the reader through
your mathematical logic.
Graphs must be plotted carefully (to scale) using graph paper.
Give your graphs titles and be sure to label axis carefully.

Question 1 : Indices of Market Concentration (page 154 – 155 text)

Here, we look at the market for large wind turbines in Canada. As a proxy for total sales,
we will use turbine capacity to generate power in MW. The companies are listed in the
following table along with the turbine capacity in MW that each sold.

Company Capacity Sold in Canadian Market
Vestas 2139.84
General Electric 1811.1
Siemens 955.82
Enercon 924.8
Repower 384.1
NEG-Micon 102.9
AWP77 45
Suzion 31.5
Nordex 26
Kenetech 24.75
Vensys 12.3
DeWind 10
Jeumont 2.25
Americas Wind Energy 1.8
Turbowinds 1.8
Lagerway 2.25
Leitwind 1.5
Pfleiderer .65
Tacke .6
Northwind .3
Bonus .15

a) Enter the data in Excel and illustrate using a pie plot.

b) Calculate market shares. To do this, in the cell beneath the capacity column, type in =
SUM(B2:B22) and then press enter. (I am assuming your data is in cells B2 to B22).
You can then make a market shares column. For example, in column C2, type =
100*B2/sum.
c) Calculate the following indices of market concentration:
i) C1 to C5.

ii) Hirfindahl index.

d) Would you describe the market as “not concentrated”, “moderately concentrated” or
“highly concentrated”. What market structure would you hypothesize based on the
information provided?

e) The graph below shows the capacity installed by each of the 9 biggest companies in a
given year. What do you think has happened to the Hirfindahl index over time? Discuss
possible implications for prices, allocative, productive and dynamic efficiency. Note: The
efficiency of this sector is highly important given the urgent need for the world to phase
out fossil fuels and replace them with low greenhouse gas energy sources.

* Data Source: Canadian Wind Energy Association.
* Note that Suzion recently acquired Repower which would increase the market
concentration.

0
 

200
 

400
 

600
 

800
 

1000
 

1200
 

1400
 

19
93

 

19
94

 

19
95

 

19
96

 

19
97

 

19
98

 

19
99

 

20
00

 

20
01

 

20
02

 

20
03

 

20
04

 

20
05

 

20
06

 

20
07

 

20
08

 

20
09

 

20
10

 

20
11

 

20
12

 

20
13

 M
W

 in
st
al
le
d/

 y
ea
r
 

Wind
 Power
 (MW)
 Installed
 in
 a
 Given
 Year
 (9
 
Biggest
 Companies)
 

Suzion
 

AWP77
 

NEG-­‐Micon
 

RePower
 

Enercon
 

Siemens
 

GE
 

Vestas
 

Question 2 : Monopolistic Competition
Consider a city with many restaurants, each of which horizontally differentiates the meals
based upon people’s preferences.

Consumers are otherwise identical except that they are willing to pay a premium for their
preferred meal type (ex. Indian). However, if the preferred meal gets too expensive,
people will choose less preferred options (ex. Italian) such that meal types are imperfect
substitutes. Hence, different restaurants have some price setting power and behave like
“little monopolies” in the sense that they face a revenue tradeoff between raising price
and getting more revenue per unit but selling fewer units.

Use the assumptions of the model of monopolistic competition as given in class. As
discussed in class, each firm’s demand curve is:

𝑞! 𝑃 =  𝑆
1
𝑛
− 𝑏 ∗ (𝑃 − 𝑃!)

Where: S = total meals sold in the market/ month
n = total firms in the market
P = price set by a representative firm
PM = market price

b = elasticity of demand parameter such that if b is bigger, demand is more
elastic, so there is less price setting power.

Each firm can be treated like a “representative firm” in the sense that firms have identical
costs and face identical residual demand curves given the output levels of other firms.
Due to this “symmetry” in the long run equilibrium, each firm will sell its variant at the
equilibrium market price (P=Pmarket) at an output level that equals total market sales
divided by the number of firms such that 𝑞 = !

!
.

You will not need to use the above equations below as I have substituted in all the
parameters.

Each representative firm has a fixed cost of F = 10 $/month and a constant marginal cost
of 𝑐 = !

!”
$/meal.

a) Explain the difference between horizontal and vertical differentiation giving an
example of each for the restaurant context.
b) Identify some fixed and variable costs for restaurant meals.
c) Given the number of firms in the market, suppose that each representative firm faces a
residual demand curve with the following equation:
qD (P) = 2400 – 16,000P

For each firm, find the following functions of q:

i) inverse residual demand, total revenue, total costs and total profits.
ii) Find the first order condition and solve for the firm’s profit maximizing
quantity and price.

iv) variable profits and profits (subtract out fixed costs).
v) Will there be entry to this market? Explain? Is this a long run equilibrium
situation?

d) Using graph paper, given the information in part a), plot the firm’s demand curve,
marginal revenue curve, marginal cost curve and average cost curve. Label the area
representing profits (if there are any) and the profit maximizing quantity and price.

e) Suppose that you correctly estimate the market demand curve as follows:
𝑄! 𝑃! = 48000 − 320000𝑃!
How many firms are in this market? (Hint: Use symmetry condition to find PM)

f) Suppose that some market entry or exit has occurred such that each representative
firms demand curve is:
𝑞! 𝑃 = 1600 − 16000𝑃,

and, the market demand curve is:
𝑄! 𝑃! = 64,000 − 640,000𝑃!

Repeat part c through e for these new demand conditions. Use a new graph.

g) Find the long run market equilibrium price and quantity and number of firms?

h) What happened to the price of each variety under the new demand conditions?
Explain why?

i) Calculate the total fixed costs of the market in the both the short run and long run
situation and compare them.

j) The benefit of all this variety is that consumers are closer to all the variety. What is the
cost of the extra variety in the long run situation (explain in words)?

k) Suppose that there are cooking shows on TV for all the different types of cuisines.
People watch the shows (since there is nothing else on TV) and as a result, they develop
stronger preferences for their preferred varieties. Use a graph sketch to show how this
(ceteris paribus) is expected to affect the long run equilibrium number of firms, prices,
firm size and average costs.

l) Suppose that the cooking shows increase the fixed costs of the restaurants but do not
affect overall sales, just preferences as discussed in k. Starting with your final graph in
k), show how this is expected to affect the long run equilibrium number of firms, prices,
firm size and average costs.

m) Suppose that it becomes possible to measure utility carefully and psychologists find
that the cooking shows and development of “more refined tastes” does NOT increase the
consumer’s happiness such that the advertising can be said to be “spurious”. Given this
assumption, discuss the effects of the advertising campaign on consumer welfare.